QNECs used in top heavy determination

[Trekker]

May QNEC's be included in determining if 60% of account balances are for the benefit of key employees?

Facts: Determination Date is 12/31 (last day of plan year). As of the 12/31/07 determination date, the plan is determined to be top heavy. However, on 6/15/08, QNEC's are made to correct ADP failure for 2007. The addition of the QNEC's results in 57% of account balances for the benefit of key employees.

Question-1: Is the Plan top heavy for 2008 (based on the determination date of 12/31/07)?

Question-2: If the answer to Q-1 is no, does it make a difference if the QNEC's were made within 2-1/2 months of the 2007 year end?

Thanks for any thoughts on this.

[BG5150]

TH calcs are done on a "cash basis," so, no, you would not use the QNECs in this case.

And, for part 2 of your question, I think the 2 1/2 month date really only applies to refunds and whether there is an excise tax.

[Tom Poje]

(or more useless pieces of fact stored away by Tom)

A few years ago someone asked a similar question at the Annual ASPPA Conference, that is, are you allowed to include a discretionary profit sharing contribution in the top heavy determination. I think most people were surprised when the IRS said, you could do that (especially since the regs would seem to indicate otherwise) Of course, such responses from the IRS personal might not reflect the actual stance of the IRS.

the exact question from the 2002 Conference is as follows:

Is a discretionary profit sharing contribution for the prior plan year that is deposited after the end of the prior plan year included in the top heavy determination for the current plan year? Let's say we have a calendar year plan, effective several years ago. We are determining the plan's top heavy percentage for the 2002 plan year. The determination date is therefore 12/31/01. The employer makes a contribution in February, 2002, which is allocated and deducted as of 12/31/01. There is a question as to whether this contribution is included in the top heavy determination for the 2002 plan year. The question relates to Q&A T-24 of the 416 regulations, which says that if a plan is not subject to 412, then the account balances are not “adjusted” to reflect a contribution made after the determination date.

Argument: The key phrase here is “account balance.” The participants' account balances, as of (say) 12/31/01, include the profit sharing contribution that is allocated and deducted for the 12/31/01 plan year end. So the guidance regarding “adjustments” does not apply to the receivable profit sharing contribution; it is already part of the participants' account balances.

The following is the author's analysis:

The question as to what contributions are considered due on the determination date is determined under §1.416-1, Q&A T-24, which says that it “is generally the amount of any contributions actually made after the valuation date but on or before the determination date.” It then goes on to say that any amounts due under §412 are considered due, even if not made by the determination date. One could take the position that this is an exclusive statement; in other words, if a contribution is NOT due under 412 and is made after the determination date, it is not considered “due.” However, the answer to the question (T-24), “How is the present value of an accrued benefit determined in a defined contribution plan” is answered, “the sum of (a) the account balance as of the most recent valuation date occurring within a 12-month period ending on the determination date, and (b) an adjustment for contributions…” The term “the account balance” includes contributions credited to the account of a participant, it does NOT mean only the contributions actually made that have been credited. For example, if a 100 percent vested participant terminated after the determination date but before the contribution was actually made, the distribution would include that contribution, even though it had not yet been made to the plan. This is because the account balance, as of the last day of the plan year, includes the contribution. So, when the regulation addresses adjusting the account balance for contributions made after the determination date, we must start with the account balance, and then apply the adjustments. Since the account balance includes the receivable profit sharing contribution, the adjustment does not refer to the receivable. The reference to §412 in §1.416-1 is with regard to a waived funding deficiency that is not considered part of the participants' “account balance,” as the term is defined. Q&A T-24 refers to a DC plan with a waived funding deficiency that is being amortized. Such a plan must maintain an “adjusted account balance” (reflecting the amount of the contribution that has not been deposited) which must be maintained until the actual account balance increases to the point where it equals the “adjusted account balance.” It is to this (unadjusted) account balance that the (waived) contribution must be added, since the amortized contribution only becomes a part of the actual account balance as it is paid to the plan. The requirement therefore has the effect of determining top heavy status as though the contribution required under 412 had actually been made. In other words, the “account balance” would not include the waived minimum funding contribution, so an adjustment is required.

IRS Response: We accept this analysis.

Again, a note of caution.

It should be remembered that IRS responses at such conferences do not necessarily represent an official position of the Treasury Department or the Internal Revenue Service.

[Bird]

Not useless at all, Tom, that's a great piece of analysis. We've always done TH calcs on an accrual basis, more out of convenience than knowing the regs intimately, but this was welcome when it came out. I think it could be rephrased as "that 'adjustment' that everyone thought was for accrued contributions really had something to do with waived funding deficiencies and you can [should] do TH calcs on an accrual basis."

[Trekker]

If I may s-t-r-e-t-c-h this, what if I'm correcting an ADP failure under VCP with QNEC's, may a QNEC contributed in 2008 for an ADP failure in 2004 be considered part of the 12/31/04 "account balance" and thereby render a previously top-heavy 2005 Plan Year non-top heavy. The top-heavy requirements were also failed in 2005, but if the QNECs in 2004 bring the top heavy ratio down from 60% to 58%, does that make the top-heavy failure go away?

I know I'm stretching an interpretion and don't expect any cites or, for that matter, any one to venture forth with an opinion. Always trying to keep the creative juices flowing!

Thanks for the replies.

[Lou S.]

I'd say that is too much of a stretch but if you are trying to pawn it off, inculde it in VCP and see if the IRS gives its blessing.

However, what would you gain? If the IRS says OK you are not top-heavy, presumably at this point the top-heavy minimum has already been made. The IRS almost certianly won't let you take it out of non-key accounts so if key-ees didn't also get a T-H you might find you have opened a different can of worms by allocating a contribution against the terms of the document.

Now if your VCP is going back to 04 & 05 because no contribs were made, it might be worth a shot but I don't think the IRS will buy what you are selling.

But I will give you points for creativity.

[Guest Sieve]

The analysis apparently agreed to by the IRS at the 2002 ASPPA (then, I guess, ASPA) conference, renders superfluous this statement in the regs' response at 1.416-1, Q&A T-24: "However, in the first year of the plan, the adjustment in (b) should also reflect the amount of any contributions made after the determination date that are allocated as of a date in that first plan year."

If those amounts (contributed after the determination date but credited "as of" the determination date) are already considered to be part of the account (i.e., accrued) as of the determination date, then of what meaning is the above sentence i n the regs? Could it mean that the adjuste tobe made is to SUBTRACT those amounts from the "as of" determination date? If so, then you'd probably never have a TH plan in the plan's first year.

I think the accrual approach to TH determination is the wrong answer for non-412 plans, at least based on the plain language of the regs.

[Tom Poje]

Sieve - I'm no longer sure about that. or maybe I am just rambling because I think it makes more sense to include such contributions.

I have a new plan, 1/1/07 - 12/31/07.

first contribution for the 2007 plan year is made in 2008.

now I have 2 plan years to consider. is the plan top heavy for 2008? what I learned many moons ago was that the cite you pointed out refers to this, so yes, I consider that contribution.

however, maybe the cite you point out actually is in reference to the 2007 plan year. no one has an ending balance from the prior year, so you are treating this contribution for that year as well.

[Guest Sieve]

Tom -- I agree that the regs' language I reference does, in fact, relate to the 2007 plan year (in your hypo)--otherwise, the balance for 2007 would be $0 if all contributions were made in 2008 (think, e.g, of a straight, old-fashioned PSP). But, if the general rule in TH is always to use accrued benefits, then why is that sentence even in the regs? There would be no reason to adjust the first year's year-end account balances for those after-year-end contributions if accrual is the rule always to be used.

Frankly, I've learned the opposite of what you have--delay employer contributions until after year-end (except for the plan's first year) in order to prevent TH for the year with respect to which the contributions relate.

How do most TPAs do it? How does Relius handle it? Is there anything out there (other than the regs) to refute that 2002 ASPPA comment? What does Tripodi say (my set is elsewhere today)?

[Mike Preston]

I thought there was special language in the regulations that applied to the first plan year. That language, too, would be superfluous, wouldn't it?

[BG5150]

How do most TPAs do it? How does Relius handle it? Is there anything out there (other than the regs) to refute that 2002 ASPPA comment? What does Tripodi say (my set is elsewhere today)?

In the Top Heavy Plan definition, Tripodi says to use only the actual contributions for plans not subject to minimum funding (401(k), PS plans). He does mention that in the ASPPA Q&A the IRS opened the possibility that the accrual method may be acceptable:

Is an accrual method permitted? In its Q&A Session at the 2002 ASPPA Annual Conference in Washington, D.C., IRS representatives placed a new spin on this issue, suggesting that the term "account balance" can reasonably be interpreted to include amounts contributed after the determination date, but allocated under the plan "as of" a date on or before the determination date. This interpretation would render several sentences in Treas. Reg. §1.416-1, T-24, meaningless and does not in our opinion accurately reflect the wording in the regulations. Bottom line, though, is that IRS seems to believe that the use of either the cash method or the accrual method to be reasonable interpretations of the law for non-pension plans, and that the IRS would unlikely raise an issue on audit with respect to the use of either approach.

Though all his examples go on to use the cash-basis for non-pension plans.

[Guest Sieve]

Mike -- The language quoted in Post #7 is the one from the regs which relates to the first year of the plan--and, yes, that would be superfluous language if an accrual method always were used in TH determinations.

BG -- Thanks for Sal's text references. Assuming the speaker at ASPPA 2002 was not a rogue (& they never are at ASPPA), Sal's advise make sense--assuming, of course, that the method used is used consistently.

[Tom Poje]

just so you know, for the Annual Conferences, the Q and As work as follows:

questions are submitted to IRS agents a few weeks beforehand, so they have a chance to look at them. of course, there is no guarantee they will, but my experience has been they look at at least some of them.

Then a few weeks before the conference, representatives from ASPPA meet with the agents to go over the questions. (I know, because I have sat in on such sessions the last few years - but not the year we are talking about)

then there is the conference and many of the questions are discussed. I remember this one being done so (its one of those questions you don't forget), and there was no change of opinion by the IRS personal involved, which they have done from time to time.

of course, like everything else in life, maybe they would be of a different opinion now. but I vaguely recall the topic being discussed in greater detail (e.g. "but the regs say...")

[Tom Poje]

Sieve:

I failed to answer your question, "How does Relius handle"

Its by the Vulcan mind meld. you put your hands on the side of the minitor and think about how you would like to perform the test.

its either that, or in plan specs on the top heavy screen, the field that says "include contributions with trade date on or before" [the default is 1/7 for calendar year plans to allow for deferrals to show up, but you can always change the date] I have no clue how that works with trade dates and stuff like that]

[BG5150]

I am guessing (read: guessing) that as long as the methodology is consistent (cash vs accraual) and the funding is consistent (match gets deposited after plan year every year) that it would be okay. The money is going to be counted eventually.

[Guest Sieve]

Don't know if the funding of contributions would have to be consistent--but, then, who really does know?--but I'd agree that, at a minimum, the accrual/cash methodology should be consistent (but then, who really knows?--or, as our Canadian neighbors would say, "but then, who really knows, ehh?").

[K2retire]

Where I used to work both top heavy and 5500 were prepared on an accrual basis. Where I work now both top heavy and 5500 are prepared on a cash basis. I doubt that this was considered in either decision, but in hindsight, I would think that consistency would help support either case.

[Bird]

With all due respect, I fail to see how consistency makes a bit of difference in the rightness of applying these rules. One way is right and one way is wrong, and using the wrong way consistently doesn't make it less wrong. Having said that, I doubt this is a burning issue on the IRS' radar screen and either way is not likely to be challenged - as long as you do it consistently. LOL.

[BG5150]

Let me ask this, then:

Say 2005 is considered top-heavy even after using the accrual method (say a 2% PS was made in 2006 for the '05 year). So, later, the ER puts in an additional 1%. Then a couple years later, the QNEC is made for a failed ADP test and using that, the plan is NOT considered top-heavy. And further assume that the PS is on a 7-year graded schedule in 2005. Do I shift everyone's 2005 vesting back to the 7-year graded schedule?

My main question is: how many years out would an "as-of" contribution be considered in Top Heavy calculations?

[Guest Sieve]

For those using accrual for TH determination, anyone's guess will do! There's nothing out there, in my estimation, that causes me to believe that accrual is even permitted (other than the 2002 ASPPA Q&A)--so, with no guidance re: accrual, there's certainly no guidance re: how far forward to reach to take subsequent QNECs into account. (Besides--if the PS contribution for 2005 was 2%, why was there any need in the first place to put in an extra 1% for TH?)

No such problems using cash basis (as per the regs).

[Bird]

I think there are questions about how to apply a cash basis interpretation on this issue, such as:

-in a pooled setting, if the employer makes a partial deposit during the year, do you allocate it, and how? As if it were the only contribution for the year, or some sort of pro-ration of the total?

-in a segregated account setting, where estimated PS deposits are made during the year, I guess that actual balances are what you use...even though participant X might have a 3.7% allocation, on the way to 4%, and participant Y has 3.1%, and Participant Z has 0% (someone forgot to start making deposits)?